The Federal Reserve's push to raise interest rates, caused by skyrocketing inflation, has been a huge headwind for growth stocks that usually trade for lofty valuations. And with the recent geopolitical turmoil of the past few weeks, stocks are going through a rough start to the year.
Fintech stocks have been getting particularly hammered. Chief among them is payments giant PayPal Holdings (PYPL 1.41%), which is down almost 40% in 2022. The business has increased sales, profit, and active accounts at a rapid pace over the past few years, and its stock price has followed.
But with a cheaper valuation today, is PayPal a buy right now? Let's take a closer look.
Image source: Getty Images.
What's hurting the stock?
Along with the broader sell-off of high-growth, high-multiple stocks, PayPal is facing a number of headwinds. Soaring inflation, as well as the fading effect of massive government stimulus to boost the economy during the pandemic, discourages users from shopping as much. That hurts the company's transaction revenue. Additionally, PayPal's 34 million merchant accounts are dealing with congested supply chains, constraining their ability to sell more goods.
A development that has received a lot of attention is eBay's transition away from PayPal and to its own payments system. This move reduced PayPal's top line by $600 million (primarily in Q1 and Q2) in 2021, although the effect will be minimal this year and beyond. Nonetheless, losing a big e-commerce partner like this is a huge worry for shareholders.
In 2020 and 2021, PayPal added 122 million net new active accounts to its platform, bringing the total to 426 million as of Dec. 31. However, only 15 million to 20 million accounts are expected to be added in 2022, a sharp deceleration from what investors have recently been accustomed to. Management has also walked back its earlier goal of reaching 750 million users by 2025, citing a new focus on growing revenue per account by getting its customers to engage with PayPal's services more.
PayPal makes money when accounts holders do transactions on the platform (92% of revenue in Q4 2021 came from transaction fees), so to have users who sign up and don't use the services is not really valuable to the business. But I can see how investors could view management's new focus as a sign that PayPal's growth prospects are limited.
Since closing at an all-time high of $308.53 on July 23 last year, PayPal's shares are down 63%. However, since spinning off from eBay and going public in 2015, the stock has returned 211%. If investors place their attention on the bigger picture, now might be an opportune time to buy this beaten-down, but market-beating, fintech company.
Zoom out and focus on the long term
I firmly believe that investors would benefit by staying focused on the next five years. Then, everything happening in the short term will seem like a blip on the radar. Using this mindset when analyzing PayPal provides some key insights about the quality of this business.
First of all, the company possesses undeniably stellar financial metrics. In 2022, PayPal increased sales 18% year over year. What stood out, though, was the annual free cash flow of $5.4 billion. Not only has the business historically been a fast grower, but it is extremely profitable. That's because capital expenditures account for just 4% of revenue in any given quarter.
Despite the expectation of slowing user growth, PayPal's network is absolutely massive, processing $1.25 trillion in total payment volume (TPV) in 2021, up 33% from the prior year. And management sees this figure approaching $1.5 trillion this year. Being an available payment option at 76% of the top 1,500 retailers in North America and Europe, much more than any other digital wallet, demonstrates PayPal's importance for consumers and merchants.
eBay's migration away from PayPal is certainly not the best news, but the announced Venmo partnership with Amazon can help alleviate any investor worries. Outside of debit and credit cards, the e-commerce behemoth doesn't accept payment from third parties, so this is a major stamp of approval for PayPal's dominance. Venmo just boosted its ability to better monetize its user base.
With a more attractive valuation today, at a price-to-earnings ratio of 33, PayPal shares might make for a worthwhile investment in the fintech market.
